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The Master Investor Podcast with Wilfred Frost
The Bull Case for China: The Best Opportunity Right Now? | Louis Gave
00:45:14
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- [00:01]
Louis Gav
China comes into this crisis, I think, better prepared than pretty much anybody out there, mostly through luck. China today has more oil and storage than the rest of the world combined. It has more natural gas and storage than the rest of Asia combined. It has more fertilizer and storage than the rest of the world combined. The reason China has all this is because eight years ago the US told China no more semiconductors. And China thought, oh my God, they can block us from this. They can block us from anything. We better store up on everything. Look, if you're looking for places in the world that have deep, deep vulnerabilities on their bond markets, there's a few countries that stand out. What always matters is the percentage of bonds owned by foreigners. And today there's three countries that stand out. One is yours, the uk and yes, bond yields are going up there. The other is mine, France. And the third is the United States. These are the three countries that essentially depend on the kindness of strangers to keep the lights on. Now, when I look at China today, what I find is the country today that has the lowest cost of capital, the lowest cost of labor, the lowest cost of electricity, and has the world's cheapest currency. And it's not even close. And that makes for a very powerful combination.
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Wilfred Frost
Welcome to the Master Investor Podcast with
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Podcast Host
me, Wilfred Frost, where we celebrate and
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Wilfred Frost
learn from the success of the greatest investors, business leaders and politics politicians in
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Podcast Host
the world, giving you our listeners the edge.
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Wilfred Frost
The Master Investor Podcast is sponsored by Elseg Interactive Brokers, the World Gold Council and BNY Investments. Please do remember the views expressed in this podcast are for general information purposes only. Nothing in the podcast constitutes a financial promotion, investment advice or a personal recommendation. More on that in the show notes.
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Podcast Host
My guest today is Louis Gav, the founding partner and CEO of Gavcal, one
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Wilfred Frost
of the best and most unique research
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Podcast Host
companies in the world, providing market research
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Wilfred Frost
to buy side firms as well as
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Podcast Host
having their own 6 billion AUM buy side firm themselves. And when they were founded in 1998, they had a particular tilt to try and focus on on Asia, which they felt at the time was under covered but cover all markets globally. Now, I've been an avid reader of Gavkal Research for years, since I graduated and joined Newton Investment Management in 2008. They are thoughtful and different and fantastic and it is a real pleasure to welcome Louis to the podcast.
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Wilfred Frost
Louis, great to see you.
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Louis Gav
This was a very, very flattering introduction. I'm very grateful. Wilfred, I think only about half what you said is probably true, but even if half is true. It's very flattering in itself. So thank you so much for this.
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Podcast Host
Well, you've got 45 minutes ahead to live up to it, which is good. I've set the bar high. I've sort of switched, Louis, my plan on this in the last six weeks since the war began. And there's so many global topics that I think, as I kind of alluded to in the intro, you write about and think about much more than so many of the commentators we hear from. And I want to get to all of that. China, Japan, Japan, India, Brazil, and very much more, but need to kick off with the war and the impact that it may or may not have from markets here.
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Wilfred Frost
You think the most likely outcome is that the US Claims some kind of victory and walks away, even if tolls exist in the Strait?
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Louis Gav
I think so. Look, let me kick off first with a disclaimer. I'm not a specialist on the Middle East. I spend most of my time looking at what's happening in Asia more broadly and to be honest, more specifically in China. But what we're really looking at is, given what's happening in the Middle east, how does this impact our region and the rest of the world? And here there's both dark clouds and light clouds and silver linings, perhaps these dark clouds. The dark clouds is obviously Asia. Most of the Middle Eastern oil was going to Asia. And so this is a real problem for us. So that is the reality. And that's why I think everybody in Asia is pushing towards some kind of development, even if the development means paying a toll on the Strait of Hormuz, even if with that money, the IRGC stays in power longer and ends up reinforced at this stage, I think everyone in Asia is like, fine, let's just get that. So perhaps there's an element of wishful thinking to my position of saying, look, that seems like the most likely outcome at this stage because the US can't regain the Strait of Hormuz by military force. And so the only way it's going to reopen is through some kind of diplomatic settlement now. And, you know, the probably this again, the sooner the better. And I think most of the US Allies, rather, in the region, whether the, you know, the, the local countries or the Europeans or the Asian allies of the United States are pushing the United States in that direction, saying, look, we can't keep this closed forever, so get something done.
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Podcast Host
And if that does get done, is
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Wilfred Frost
that a massive positive for oil prices
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Podcast Host
or is in fact, there's still quite a lot of risk and complication priced in to that less negative outcome than we have now.
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Louis Gav
When you say positive, you mean all prices come back down?
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Podcast Host
Yes.
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Louis Gav
Sorry, yeah, sorry. No, no, just making sure we're on the same page. The. Look, I, I think the big challenge we have is even if it reopens tomorrow, we now have a 6 weeks to 2 month air pocket in the global economy because the ships that should be arriving now are no longer arriving. And, and even again, you reopen tomorrow, the ships are going to take quite a while to, to come back out. And so however you cut it, you know, we're, we're looking at a two month supply chain dislocation for the world here. And of course it's not just oil, it's the natural gas, it's the fertilizer, it's the sulfuric acid, it's the urea, it's fertilizer. It's like all these things and, and these can, can of course compound. Right. If you don't have the fertilizer today, you're not planting. And so I think the inflationary shock coming from this is pretty much now baked in the cake. And of course the longer we stay closed, the bigger the inflationary shock. But that brings me to the silver lining to this perhaps crisis is that in an age where all of a sudden we are experiencing this massive inflationary shock, I think that the times when the US and China could turn around and try to trip each other up and you'd have these trade wars and these threats of tariffs and this is now gone. I think because of this, China and the US are almost condemned to get along. They might not want to, they might not like to, but Trump and Xi are scheduled to meet four times in the next 12 months, which has never happened, by the way. You've never had a US president or Chinese president scheduled to meet four times over a 12 month period. And I don't think they're going to meet to discuss the weather. And so you have these four meetings which should be a reset of the US China relationship. And I think in the wake of the Iran war, it might very well be a very positive reset where essentially the US says, you know what, we can't take two inflationary shocks at the same time, we can't antagonize China and at the same time have this trade of Hormuz close. It's sort of one or the other. I don't think you can do both.
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Podcast Host
That's really interesting. I want to unpack that in that positive view. And China specifically in A moment, just
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Wilfred Frost
dwell on the sort of negative view
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Podcast Host
for me for a moment. I think you said there the inflationary shock is already baked into the cake, meaning in the economy to come, is
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Wilfred Frost
it priced into the market or are
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Podcast Host
people underestimating the actual impact this is going to have on both inflation and GDP growth in a lot of those countries you mentioned across Asia?
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Louis Gav
So I would say it really depends on your markets. I think it's increasingly you're starting to see the crises in the world's poorer countries, the Pakistans, the Sri Lankas, et cetera, where already seeing fuel rationing, where you're already seeing food prices go, go up aggressively. To your question, is it priced in the markets? You could say, well, you know, fertilizer prices are now up by more than a third and gasoline prices are up by about 30% in, in the United States and by 40 and 50% in Europe. So you could say, well, suits look, you know, it is priced here. Here it is. Is it priced in the price of equities of bonds? To be honest, I don't think it is. And I don't think it is again, because perhaps we haven't yet felt the full shock. And I think we haven't yet felt the full shock for a few reasons. The first is up until a week ago, the boats were still arriving from the Middle east because they'd left six weeks ago. Right. And it takes six weeks to go to most destinations. So we haven't had yet the empty boats. The empty boats are starting now when the ports, literally no one's arriving. So the, the real shortages essentially start now, but they probably don't really start for another six weeks or two months because in this misfortune that we're now experiencing, at least we had two previous crises. We obviously had the COVID crisis of 2020 and we had the Russia crisis of 2022. And with that, I think most businesses started already to move away from just in time inventories to just to more just in case. You'll remember that this was one of the big themes that the just in case was one of the big themes. Following Russia's invasion of Ukraine. All of a sudden everybody starts to say, well, you know what, maybe I should have a little more helium since Ukraine's a big helium producer. You know what? Maybe I do need to store more electricity. I do need to store to re up my grid. So take Europe as an example. I think it's fascinating that today the electricity price spike in Europe is nowhere near as bad as what we had in the Ukraine war. So for now, I think we came into this crisis perhaps a little bit better prepared than the previous two. But you can only run down your inventories for so long and this is why, you know, if this lasts another six weeks or two months, I think the economic pain really starts to get felt and then the market pain will be there as well.
- [11:08]
Wilfred Frost
This episode of the Master Investor podcast with Wilfred Frost is sponsored by BNY Investments, a trusted partner for many delivering financial solutions to investors and institutions worldwide. This sponsorship does not constitute financial advice. This episode is sponsored by the World Gold Council, the global experts on gold. They champion gold as a trusted strategic asset, providing market leading research to help investors understand gold's role and modernize how
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Podcast Host
gold is owned, traded and used.
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Wilfred Frost
Developing industry standards and market infrastructure. Learn more@goldhub.com.
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Podcast Host
Just before we move on to market specifics and some of the positives touch on Europe for me.
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Wilfred Frost
Does it affect everyone the same? Are there different short and long term effects like there are for Asia as well?
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Louis Gav
So I think when you look at the problem from the Middle east, there's several categories of products that are being impacted. The obvious one we all think about, of course, is energy. And here you have, if you look across Europe, you have different countries whose economies are more or less energy intensive and whose own economy have to import more or less energy from the Middle East. So if you take my own country of France, we're actually not in that bad spot because we do have a lot of hydro and we do have a lot of nuclear for us to fall back on. And so we're a lot less dependent on imported energies than say, Germany. Germany also happens to be quite an industrial economy which is energy intensive. So Germany might be more vulnerable to what's happening. It's not like everything is smooth sailing for France because the other thing that the Middle east is extremely important for is fertilizer. And so far, somewhat amazingly, but grain prices have not moved up. If you look at wheat, if you look at corn, if you look at soybeans, if you look at all the grain prices, they really haven't moved up. So unless come harvest time, wheat prices go up, I think you're going to get like massive food, massive farmer riots in France. Now you could say, well, that's an easy prediction that happens every year. But I think this year is going to be, come harvest time, September, October, it's going to be particularly, particularly bad.
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Wilfred Frost
Well, I wonder whilst we're on France
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Podcast Host
to get your view on this, I wonder whether the back end of the year with the necessary, the need to pass a budget and a looming presidential election, whether the bond market reacts as well. I mean, looking at the UK the 10 years back above 5% today, you'd kind of look at the French bond market and think it's relatively calm, all metrics considered. I wonder if that worsens as we near the back end of the year as well.
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Louis Gav
You're absolutely right, I think. Look, if you're looking for places in the world that have deep, deep vulnerabilities on their bond markets, there's a few countries that stand out. And for me, the ratio has never been debt to gdp. I think that's a silly ratio. You're comparing a stock and a flow. What always matters is the percentage of bonds owned by foreigners. This is a guide of whether domestic savings are enough to essentially keep governments going along. Governments need to fund themselves in one of two ways. They could say, okay, fine, I'll fund myself through taxes. But there's people who don't like paying taxes, but who like lending money to have a high savings rate and who like lending money to. To their government. China is a prime example of this. Today. China has fairly low taxes, but has the lowest bond yield in the world because Chinese people save a lot and all the savings go into government bonds. And so Chinese government gets to borrow cheaper than anybody. And. And as long as you borrow from your own citizens, you can keep that going forever. And you can keep it going for a very, very. Or forever is a long time, but you can keep it for. The problem becomes when you start borrowing from foreigners, because one day foreigners wake up and say, you know what? Why do I own all these French bonds? Or why do I know all these. Why do I own all these British bonds? I don't like the politics. I don't like this. I don't like that. I'm out. And today there's three countries that stand out that borrow disproportionately from foreigners. One is yours, the uk and yes, Bornells are going up there. The other is mine, France. And the third is the United States. These are the three countries that essentially depend on the kindness of strangers to keep the lights on. And again, that doesn't mean that that stops, but it means that all of a sudden you are vulnerable.
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Podcast Host
Really interesting. And I want to touch on the US side of that in a moment
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Wilfred Frost
before we move off the war.
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Podcast Host
You guys did a really interesting piece recently on defense stocks, which we all would have expected to be shooting through the ceiling off the back of the
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Wilfred Frost
war, they've rolled over somewhat.
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Podcast Host
Talk me through your assessment of that.
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Louis Gav
So I've actually been bearish defense stocks for a little bit, and my take is actually quite different, is that warfare has changed massively. I think Ukraine was a prime first example of this, and then the Red Sea and the Houthis was a second. And now we obviously have a third element of this. The reality is that Since World War II, every effort by every military was first and foremost to control the sky. If you control the sky, then chances are you're going to control the battlefield. And controlling the sky was an extremely, extremely expensive proposition. You know, fighter planes cost a fortune. Satellites cost a fortune. And with the Ukraine war, we found out that actually controlling the sky cost a few tens of thousands of dollars. The drone warfare has completely upended the military equation. It's all of a sudden, why pay US$275 million for an F35 seaplane? And not only the controlling the skies, but the delivery of firepower has also been upended. With a $50,000 drone, you can now sink a billion dollar battleship. And so that equation, and to take down the $50,000 drone, you need a $2 million Patriot missiles. So the spending has become so asymmetric. And you're seeing this today in, in the Gulf, in the Persian Gulf, where the US Navy can, cannot be within a thousand miles of Iran, which then raises a whole question mark, is like, what's the point of a Navy if you can't get it close to where the battlefield is? Because who wants to? These aircraft carriers now cost $6 billion if they can be taken out by a $50,000 drone. You know, the maths, the maths just don't work. And so we are living through right now essentially an upending of both the financial and I would say the geopolitical infrastructure of the past 80 years. You and I grew up in a world in which we had three key assumptions that we could take for granted. The first assumption that everyone took for granted is that you saved in US Treasuries whether you were an individual, whether you were a company, whether you were a government, you saved in U.S. treasuries because in a crisis, that was the most deep, liquid market, and you could transform your Treasuries into commodities. So if you're Japan and there's Fukushima and you decide to shut down your nuclear power plant, you can sell your Treasuries and buy oil and coal and natural gas, and you get through the emergency that you're having, that assumption was essentially broke down with the Russia Ukraine war. When we seized Russia's treasuries, we said, you only get access to treasuries if we say you do, we being the Western world and really being the United States. So that was the first assumption and the response to this, everybody turned around and said, fine, then I'm going to buy gold instead. And so central banks became huge buyers of gold. Gold prices tripled. The second assumption was by buying gold is I can transform my gold into oil or into food or into fertilizer whenever I need. Because the US Navy controls the world's seaways. Because I can always have my stuff, my fertilizer delivered by the US Navy. That assumption has just been destroyed. So that's the second assumption that has now been left for rubbles. And therefore you have to question, going back to your question on defense, if the US Navy can no longer control the seaways, what's the point of spending all this money on defense? I'm much better off buying $50,000 drones and $80,000 ballistic missiles from China. So these defense companies live off the sale of systems that cost millions of dollars and that are now obsolete. And that's where we are in warfare today.
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Wilfred Frost
Just to pick up on something you
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Podcast Host
said in the middle of that, the second big assumption we've lived our lives on, that the US will keep the waterways open. I guess we touched on this on the top, but we presumably don't know what follows that yet. And what is the big implication of it? That everyone's going to have to do more homegrown. And whilst we transition for countries like the UK to be able to do more of that, we're going to have higher inflation.
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Louis Gav
That's exactly right. I think. What, what ends up on the other side of this? Look, if you're India, let's take India as an example because India is really impacted by what's going on in the Middle east right now. India has roughly US$700 billion in treasuries that they kept for the rainy day that was the, the rainy day fund. Well, the rainy day just just occurred. It's like it's right now and they're looking around saying, okay, what I need is fertilizer, what I need is food, what I need is natural gas, what I need is energy. And I can't transform my US Treasuries into the fertilizer that I need. Literally. India called up China because China still has fertilizer. And China said, and India said, name your price, I know you have storage the reason China has storage of everything. China today has more oil in storage than the rest of the world combined. It has more natural gas and storage than the rest of Asia combined. It has more fertilizer in storage than the rest of the world combined. The reason China has all this is because eight years ago the US told China no more semiconductors. And China thought, oh my God, they can block us from this. They can block us from anything. We better store up on everything. So they stored up on everything. So China comes into this, inventory is loaded up. So now everybody, Philippines, Thailand, India is calling up China, say, hey, can we buy some of your fertilizer? Name your price. China's like, no, mate, sorry, I'd love to help. I'm keeping mine because I, you know, gotta take care of my own people first. And so to answer your question, the end result, whether you're uk, whether you're in India, whether you're Philippines, is you're gonna turn around and say, you know what? What good are these US Treasuries? What good is this stock of gold? I can't sprinkle my gold on my fields to grow food. I can't shove my US Treasuries in the gas container of my car for the gas container to get going. So everybody around the world coming out of this. So even if it ends tomorrow, the reality will remain that the US no longer controls the world's waterways. And in that environment, everybody's got to build up inventories. So depending who you are, you need different things. Like Chile isn't going to build a copper reserve and Canada isn't going to build an oil reserve. They don't need it, they've got it here on this front. Europe as an aggregate is really, the main thing is we're energy deficient. That's broadly it. The rest of the stuff we can actually produce as an aggregate in Europe. So the end result of this is that everybody's going to turn around and need to have much smarter energy policies. And here, this is perhaps another silver lining to this crisis is that our energy policies in Europe have been completely upside down. I think that the crisis of Ukraine, the crisis in Iran is forcing us to review this and saying, okay, you know what we need to do what China did, which is embrace energy in all of its form. So solar, bring it in. Wind, bring it in. Nuclear, bring it in. Natural gas, oil, coal, we're going to do it all. Today, China produces more electricity than the US and Europe combined. And the cost of electricity in China is a fraction of what we pay in Europe or even what North Americans pay, this is going to have to change and I think it is going to change. And by the way, that's another reason to think one of the silver linings of this crisis is people will now suddenly turn to China, that both Europe and the United States and they've been pushing China away for the past eight, nine years. They're going to turn around and say, actually you know what China, I will have those solar panels please, because I need them, so please send them over. You know what China, the sub $10,000 electric cars that you produce, I would like them, please send those over. You know what China, those cheap wind, wind turbines, those, those clean coal power plants, those nuclear power plants that you produce at half the cost of France. We'll take the, we'll take them all, thank you very much. We need them. So coming out of this, I think is, is a much more realistic appreciation of our own, of our own weaknesses, whether in Europe and North America. I think to a large extent in Europe and North America we, we over overestimated our strengths. We're like, you know what, we can ramp up our cost of electricity, we can afford to have completely idiotic energy policies and our system will cope. Turns out it won't.
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Podcast Host
Let's touch then on your view on China because it sounds like the war just doubles down on the view you've held for a while, which is that you think China is structurally undervalued.
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Louis Gav
Oh look, China comes into this crisis I think better prepared than pretty much anybody out there. Mostly through luck. Mostly through luck. Again, I think it's hard to underestimate the trauma for the Chinese policymakers of the 2018 decision to block China from semiconductors. The Chinese policymakers genuinely panic. You see this in the bank data. It's one of my favorite charts to explain what's happened in China in the past seven, eight years. If you look at bank data, at bank lending to real estate and the consumer, starting in 2018, it plummets and all the money goes to industry. What happened in 2018 when we blocked them from semiconductors is the Chinese policymakers turned to the banks and said, guys, we need to become self sufficient on every single industrial vertical because they're blocking us on semiconductors today. Tomorrow it could be car parts, it could be tires, it could be turbines, it could be anything. They clearly want to trip us up so we have no choice but to become self sufficient. And so all of China's savings, which happen to be massive, it's by now a big economy and with a very high savings rate. All of China's savings were redirected essentially into building up national resiliency. And so today, and I think the crisis that ended up happening for China wasn't the crisis that they'd expected. I think the one they were expecting was that at some point the US Would ramp up the import restrictions into China. So it's not the crisis they were expecting, but at least they got ready for a crisis. So coming into this, they're ready for it. None of us are. Nobody else is.
- [27:30]
Wilfred Frost
This episode is sponsored by Interactive Brokers. Building wealth starts with the right broker and Interactive Brokers helps you reach your goals with powerful tools, global market access, low costs, and unmatched financial strength. That's why the best informed investors choose IBKR. Learn more at ibkr.com masterinvestor this episode of the Master Investor Podcast is brought to you by lseg, the leading global financial markets infrastructure data and analytics provider. To learn more about how ELSEG connects businesses, investors and markets worldwide, visit elseg.com.
- [28:19]
Podcast Host
So clearly you think China's undervalued. You've made a very good case for that. I guess my question is to what extent? Given that since those post COVID lockdown lows, equities in China have rallied and the currency has begun to rally, obviously in a more measured way. Is this the start of a 10 year bull market for those types of assets?
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Louis Gav
Look, I believe it is. And you mentioned valuations, which are of course an important component of any investment decision. But at gafcal, when we look at markets, we'd like to look at them actually through four prisms and valuation is only the last one. The very first prism we look at is the fundamentals. You want to make sure when you invest somewhere that a you're not fighting policymakers, that you have policy tailwinds rather than policy headwinds and you want to make sure that whatever you're investing in makes sense. Now when I look at China today, what I find is the country today that has the lowest cost of capital, the lowest cost of labor, the lowest cost of electricity, and has the world's cheapest currency. And it's not even close. And if people don't believe me, I always tell everyone you have to go over there. You stay in Four Seasons Hotel for 100 US a night. You have some of the best meals you'll have in your life for $25 per person. Incidentally, if you go back to 2010, 2009, 2010, back when everybody was telling you that the US was going to face a lost decade, that it was going to be Japan all over again, that it was a new normal. Back then the US had the cheapest cost of capital in the world. It had one of the cheapest costs of labor, it had by far the cheapest cost of energy, thanks to the Shell revolution. And the US dollar was one of the cheapest currencies in the world back then. And that makes for a very powerful combination. That's a very, very potent combination today. You have that combination in China. And yes, the big difference from recent years is you now have policymakers that are clearly committed to a wanting a stronger currency which encourages the Chinese savings to stay at home instead of fleeing abroad like they've been doing in 2018-2024. The currency was broadly heading lower since then. You now have a, a stronger currency, but. And you also have a government that essentially each time the market's gone down, 10, 15% steps in to bring it back up. So, so that, that's the fundamental bit. The second pillar we look at when we look at a market is we look at the momentum. I'm, I'm a bit of a coward and I hate fighting the market. I. You don't want to. I don't like fighting. I played for rugby for 30 years and fighting people who are much bigger than you is tough. It's a, it's a hard way, it's a hard way to make a living. It's still tough day at the office when you, the guys on the other side are much, much bigger than you. Now the market is it. You know, I start for the premise the market is much bigger than me. So I like things with, with broadly positive momentum rather than negative momentum. Now today the renminbi is as the best momentum in the world. It's up six and a half percent against the US dollar over the past 12 months. And in itself that's fascinating because historically the Chinese central bank, each time there's global uncertainty, they would freeze the value of the renminbi. This time they're not doing it. It's literally grinding higher every single day. So that's the momentum. The third thing you look at is the investor positioning. And on this front I take a lot of comfort in the fact that half of the meeting I still have people tell me China is uninvestable. It's the second biggest economy in the world. It accounts for roughly 18% of GDP and you'll be hard pressed to find anyone that has more than 5% of China in their portfolio. Meanwhile, you know, to compare and Contrast with the US the US is roughly 25% of global GDP and the US is roughly 2/3 of the world MSCI. So when you look at the US today and you say, you know what, I'm just going to buy the world msci, which is the world index, therefore I'm going to be 2/3 in the U.S. you're making the bet that over the next decade two thirds of global profits are going to accrue to American companies. Now if you think that's the case, that's great for a number of reasons which probably deserves a whole other call. I think that's highly, highly unlikely. So in terms of investor positioning, I'm very happy being long China. The fourth reason is the valuations, the one you highlight, the one you started with. And yes, China as a market, the currency is the cheapest in the world and it's not even close to the bond market is one of the only major bond markets that has delivered very adequate positive returns to investors for the past five years. I think everywhere else in the world, you're essentially in most markets in the world, the us, Europe, uk, Japan, you're in a situation where essentially policymakers are robbing Peter the PayPal. They keep crushing the bonds and following policies that essentially mean currency debasement and bond debasement so that equity markets can stay up. And China is not at all in that situation. The bond markets have, have actually delivered very, very decent returns for China. But the overarching theme for me in China this is, you know, how I'd look at the broader markets. The more important thing for me when I look at China and the reason I am excited about the market today is that there is a new development. Having been in China since 97, having lived there and in Beijing and Nanjing and in Hong Kong, what I now see in China for the first time is the emergence of truly world class companies, companies as all that money has gone into industrial investment, as all the money's, you know, essentially got taken from the stock market, from the real estate market to push up the China's capacity of production. And as you've seen companies start to leapfrog companies in the west in so many fields, you're now seeing companies emerge that you know are going to be world champions. The obvious example is a byd. I know you already have BYD cars on the streets of the uk, but wherever you travel and for, for the listeners who travel in the emerging world, increasingly wherever you go you see Chinese cars that are genuinely world class cars. Then you've got robotics and automation where essentially China is taking over the world. You have. Sorry, go ahead.
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Podcast Host
Oh no, I was just going to just off the back of the very convincing bull case there on China wanted to move on to a couple other markets before we run out of time. Off the back of that briefly, I
- [35:06]
Wilfred Frost
mean, is this bullish for the rest of Asia?
- [35:09]
Louis Gav
Yeah, it's look, growth is good news, right? I start off with that premise. A bigger pie, a rising tide lifts all boat. A bigger pie is, you know, feeds everyone. It's Asia. I think the broader Asian markets have struggled from the fact that Asian Chinese growth has been very lackluster for the past seven or eight years because of these policies of redirecting all of the savings into national resiliency. And so yes, a policy focused more onto reboosting consumer confidence, a policy focused more on moving or reducing Asia's dependency on the US dollar, allowing countries like Vietnam, like Indonesia, like Thailand and others the ability to industrialize on credit on the cheap without dependency on the US dollar. I think all of that is a tide that brings all boats up.
- [36:11]
Podcast Host
I want to bring it back before we conclude, just to the US market if we can. Louis. And the extent to which you think it is currently priced for perfection and what happens if we do see, which
- [36:24]
Wilfred Frost
there's been quite a lot of hints
- [36:25]
Podcast Host
of of late, the AI Capex cycle just start to roll over a little bit.
- [36:32]
Wilfred Frost
Do you think we're priced as if that can never happen at the moment.
- [36:36]
Louis Gav
So I do have this emerging market bias. I've been doing emerging markets for 30 years and one of the first rules I think you learn in emerging markets is that if you go from being really, really stupid to just plain stupid, that's such an improvement that a lot of assets can get rerated massively, you can make lots of money and that move from really, really stupid to just plain stupid. By the same token, and to your point of your question, if things are priced more or less for perfection, if you go from perfection to just maybe just a tiny bit stupid, then you have a big problem. Now what strikes me as interesting in the United States is that the growth of the past 30 years in the US equity markets was essentially premised on the idea of very capital light business models. I actually wrote a book about this back in 2004 called our brave New World where I talked about platform companies, highlighting that the model of companies used to be vertically integrated with companies that designed the good, produce the good and sold the good, but that the model of the future was the company that designed the good and sold the good and led the manufacturing bid in the middle to somebody else, somebody in China, somebody in Poland or in Morocco or wherever else. And in so doing, you ended up with much higher returns on invested capital and much more stable returns on invested capital. And so the point of my book in 2004 was that the companies that successfully transitioned from the old vertically business integrated model to the platform company business model, those would re rate massively. All the more so since as you become less and less capital intensive and you generate these cash flows, the only thing you can do with this money is buy back your shares. And I think that's what you've seen at Microsoft and that's what you've seen at Apple, and that's what you've seen at Amazon. These guys have been the ultimate platform companies. The growth and the outperformance of the United States was primarily premised on this capital light business model. And what's fascinating is the new generation of leaders today are saying, look, that was then. AI is going to be such a massive thing that we now have to embrace a massively capital intensive business model. We're going to become more capital intensive than a steel plant. We're going to become more capital intensive than the auto industry has ever been. We are going to plow so much money into data centers, into accumulating chips, into building our own power plants to feed our data centers, because the productivity gains that are going to come from AI are going to be so gargantuan. So the first thing we have to acknowledge is that the quote unquote successful companies in the United States have completely changed their stripes. They've moved from low capital intensity to massive capital intensity. Do I still want to pay 30 times earnings, 35 times earnings for a capital intensive business? You have to come to one of several possible conclusions. The first is to say, you know what, they're right. AI is like, it's going to be such a game changer. They're right to do this. That's option one. Option two is to say, you know what, maybe they're doing this because they've had a zero cost of capital for 20 years. And so while before they were all capital disciplined, they've lost all that capital discipline. They're like Chinese companies of 10 years ago, when Chinese companies of 10 years ago had zero cost of capital and would throw anything on the wall to see what sticks. Because when you're valued at 35 times earnings, you don't have to be capital disciplined. So that's the second option. And going back to the point where you go from being very smart and perhaps not quite as smart, or you do like I do, which is to say, you know what, maybe that falls into the too hard bucket. Maybe like deciding this one is like, yeah, maybe AI is going to revolutionize the world and these guys are going to be right on all these investments, although the odds that they're all right at the same time seems low because, you know, you need, you still need winners and losers. So perhaps I'm going to try to do something else. Perhaps I'm going to go into the parts of the market that, that aren't quite as crowded. I, I don't think I'm, you know, you said we, we talk to the smartest people, et cetera. I really don't think I'm the smartest guy in the room. I never was the biggest rugby, like, biggest player on the rugby field. I'm not small, but I was never the biggest guy. And I know I'm not the smartest guy in the room. And right now it feels to me like all the smartest guys in the AI room and they talk to each other all day and the debate all day, et cetera. So I just feel like I need to go into a less crowded room because the odds of me winning in that room are too low.
- [41:27]
Podcast Host
It's a really fascinating take, Louis, and appreciate it a lot. We are basically out of time, so I'm going to jump to the final question, which is a flag to. Before we ask it to everyone, maybe you've hinted at some of your answer already, but what is your overriding piece of investment advice for our listeners?
- [41:49]
Louis Gav
It's a tough question to answer, of course, but I would say, look, the first thing you have to know as an investor is to know yourself, right? And it's an easy thing to say for a guy like me who's in his mid-50s, who's gone through a few cycle. But the, and I, I now know, having made a lot of mistakes along the way, I now know the situations I'm good in and the situations I'm bad in. And, and so much of this game is making sure to not put yourself in the situation where you're going to make the wrong decisions. So that, that's number one now to put yourself in the best possible decision. When it comes to investing, diversification does help. But when you embrace your portfolio construction and your diversification, which allows you to sleep at night and at least for me, allows me to not panic in the, you know, when things go against me, etc. Because hopefully not everything goes against me at once. You, I think you have to build, you have to build a portfolio, a diversified portfolio in a smart way and a smart way essentially for me, there's four asset classes that each have their own life cycle and each sort of sometimes are correlated with each other, sometimes are not, for different reasons. And these four asset classes for me are of course equities, of course fixed income, but energy and metals. These are the four main asset classes and a well diversified portfolio. So, so if you want to rest at night, just say, you know what, I'll put a quarter in each, go to bed, and you'll actually do fine. Over time, you'll do great. If you want to be smart, you eliminate one or two out of the four and you focus on the, on the other two. And you focus hard at picking the best components of the other two. That's what we try to do in our firm. It actually does take work. But that's my approach to financial markets. Well, it corresponds to my, it just corresponds to my own sort of behavior and ability to withstand shocks.
- [43:54]
Podcast Host
Well, Louis, it has been an absolute pleasure having you on with us today. Really do appreciate it, and we thank you so much for your time, particularly I know, as you've got a busy day ahead of you there in New York. Louis Gav, thank you for joining us.
- [44:09]
Louis Gav
Thank you so much for having me.
- [44:10]
Wilfred Frost
Next week on the Master Investor Podcast,
- [44:12]
Podcast Host
we'll be joined by Dan Niles after what's going to be a very busy week of tech earnings. Nobody better to hear from than Dan.
- [44:20]
Wilfred Frost
Please make sure to hit, subscribe or
- [44:22]
Podcast Host
follow on your podcast or video app to make sure you don't miss that
- [44:27]
Wilfred Frost
and any future episodes. But thanks again for listening. The Master Investor Podcast is sponsored by Elseg Interactive Brokers, the World Gold Council, and BNY Investments. Please do remember the views expressed in this podcast are for general information purposes only. Nothing in the podcast constitutes a financial promotion, investment advice, or a personal recommendation. More on that in the show Notes. This podcast is produced by Paradine Productions and Master Investor limited In association with Birdline Media. If you've enjoyed the show, please do subscribe on YouTube or click follow on your podcast platform, and you'll be automatically notified each time a new episode drops.